Russia-China Natural Gas Agreement Crosses the Finish Line

  • photo courtesy of Mark Turner https://www.flickr.com/photos/markturner/5823673557
    May 28, 2014

    A decade-long negotiation between Russia and China appears to have finally closed on May 21, during Russian President Vladimir Putin’s visit to Shanghai. The $400 billion natural gas supply contract between Russia’s Gazprom and China’s National Petroleum Corporation (CNPC) entails 38 billion cubic meters (bcm) or 1.34 trillion cubic feet (tcf) of Russian gas supply annually to China for 30 years via a new pipeline. The commercial agreement between the world’s top energy supplier and the largest energy consumer came at a particularly interesting time when Russia’s relationship with its European energy customers is under strain. This pipeline gas deal highlights the growing importance of robust Asian markets over comparatively stagnant European markets and mirrors the eastward shift in Russian energy strategy. 

    Q1: Did the recent tension with Europe lead Russia to seal this deal? 

    A1: The current tension between Russia and the West over Ukraine may have nudged forward the pipeline gas deal with China, but it did not drive the deal. Geopolitical tensions, triggered by Russia’s annexation of Crimea and uncertain ambitions in southeastern Ukraine, have put Russia’s already-weak economy under further pressure. It also increased Putin’s political need to return from China with a big gas deal in order to demonstrate the West cannot isolate Russia. 

    The most significant impasse was over the price.  Gazprom wanted to use oil-linked sales contracts in Europe as a benchmark price while CNPC proposed a lower price that was based on its pipeline gas imports from Turkmenistan, below $10 per million British Thermal Unit.  While Gazprom puts the total value of the deal at $400 billion, the agreed-upon gas price has not yet been disclosed and the Chinese side has been notably quiet on this point.  But, the Russian asking price has likely come down to a level much closer to China’s Turkmen import price. Also, in response to China’s request, volumes from two named East Siberia fields will be dedicated to supply the gas under this deal.

    Q2:  Does this deal signify a new and warmer phase in Sino-Russian relations?

    A2: There is growing economic synergy between the two countries, particularly in energy.  While Russia needs diversified and growing market for its natural gas supply to help sustain its economy, China needs greater and diversified gas supply to meet its domestic energy demand that is essential for its economic growth and to improve environmental conditions.   

    To underscore the closer relationship between the two countries, several notable energy deals have been announced within the past 12 months. For example, a deal for Russia’s Novatek to supply at least 3 million tons of liquefied natural gas (LNG) to CNPC was also finalized during the Putin visit to Shanghai.  Also, in June 2013, Rosneft agreed to double its oil supplies to China in exchange for $60-70 billion pre-payments from China. More notably, the Russians have agreed to allow Chinese equity investment in Novatek’s Yamal LNG project (a 20 percent stake by CNPC) and in Rosneft’s oil development project in East Siberia (a 49 percent stake by CNPC)—rare moves by the Russian energy sector, which is generally closed to foreign equity investment. 

    Q3: How significant is this deal to China and Russia from an energy market perspective?

    A3: The agreed-upon Russian gas supply volume is equivalent to a quarter of current Chinese natural gas consumption and about 10 percent of estimated demand by 2020. Depending on the Chinese gas demand outlook, the Russian supply volume would not preclude China’s future interest in concluding a deal to import LNG from the United States or anywhere else. 

    Russia is acutely aware of how robust natural gas production in the United States and future U.S. LNG supplies along with other LNG supplies coming online in the next decade will compete directly with Russia for market share in Asia.  Given stagnant energy demand in Europe, Russia aims to increase its gas supply to Asia from 6 percent of exports today to 31 percent by 2035.  Sealed last week, the Russian pipeline gas supplies to China will likely begin in four to six years when global gas markets will see substantial levels of new supply added from Australia, Canada, and East Africa, in addition to the United States.  From the Russian perspective, the deal was always important to secure timely access to growing Asia gas markets but was perhaps pushed over the finish line by the additional need to send important geo-economic signals to the West in light of the crisis in Europe.

    Q4: Does this deal mean that China is more interested in pipeline gas than liquefied natural gas imports?

    A4: The Chinese government sees natural gas as a viable energy source to help address its over-reliance in coal, which supplies about 70 percent of the country’s electricity generation but is a major cause of severe air pollution. China has become a growing natural gas consumer and importer as its domestic production is outpaced by demand in recent years. 

    China has been pursuing both pipeline gas and LNG imports. As of 2012, about one-third of the domestic consumption is met by imports, and the import volume is split nearly half-and-half between pipeline gas from Turkmenistan and Myanmar, and LNG from Asian and Middle Eastern producers like Australia, Qatar, Indonesia, and Malaysia. The current Chinese government plan includes more-than-doubling the LNG receiving capacity in the next five years—31 mmt/y or 1.51 tcf/y today at nine terminals to over 80 mmt/y or 3.9 tcf/y at 15 terminals by 2018

    It is uncertain, however, whether there is enough room for both additional pipeline gas and LNG in China’s natural gas market down the road.  One determinant is the future volume of pipeline gas import from Central Asia and Russia.  The Turkmen gas supply volume could triple to 65 bcm/y or 2.3 tcf/y  while the Russian gas supply volume may eventually be about 68 bcm/y or 2.4 tcf/y.  Another major determinant is the pace of shale gas development in China with resources estimated at 1,115 trillion cubic feet according to a U.S. Energy Information Administration-commissioned study.

    Q5: Does the supply volume commitment endanger future Russian gas supplies to its European customers? 

    A5: There should be no direct competition as the gas supplies to Europe come from West Siberia while the supplies to China will come from East Siberia. Specifically, the freshly inked agreement will see Gazprom produce and supply from two new producing fields in East Siberia.  Gazprom is expected to invest $55 billion to develop large gas fields in East Siberia and to build necessary pipeline infrastructure to the Chinese border.  The region has become critical for the future viability of Russian energy sector as production declines in West Siberia, whose giant fields were discovered first and are much closer to Europe. 

    Moreover, the prolonged economic crisis in Europe and the resultant slowdown in the regional energy consumption have posed an economic difficulty to Russia. Energy export revenue accounts for over 70 percent of its total export revenue and half of its federal budget revenue. Europe has been the destination for about 80 percent of the Russian oil and gas exports. The sluggish energy demand in Europe was another key reason for the Russian leadership to seek new opportunities in Asian markets.  

    Jane Nakano is a fellow with the Energy and National Security program at the Center for Strategic and International (CSIS). Edward Chow is a senior fellow at the Energy and National Security program at CSIS.

    Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

    © 2014 by the Center for Strategic and International Studies. All rights reserved.

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